The collapse of Silicon Valley Bank and the impact on stressed tech companies should be a lesson to treasurers about where and how they deposit vital funds. Laurent Descout, CEO and Co-Founder of Neo, offers treasury teams a timely reminder of four simple steps to mitigate the risk.
On 14 March 2023, the largest US bank failure since the 2008 global financial crisis occurred as regulators closed Silicon Valley Bank (SVB). SVB was a favourite among tech startups that, after record levels of investment between 2020 and 2021, deposited huge amounts of money in the bank.
When rumours started swirling about the bank, customers panicked and started pulling their money out. But as those funds were reportedly tied up in long-term instruments, the bank couldn’t meet the scale of customer withdrawals. In the end, depositors pulled a staggering $41bn out of the bank, leading to its ultimate demise and a weekend of uncertainty until regulators stepped in.
This whole affair has called into question the ways in which treasurers manage their deposits and mitigate risks associated with a single point of failure. Many are now looking to diversify deposits across more than just one banking partner, which is a good place to start.
1. Diversify deposits with multiple banks
The tale of SVB should be a cautionary one for treasury teams about the risks of putting all their eggs in one basket. Even though the Federal Deposit Insurance Corporation (FDIC) has protected all deposits with SVB and the similarly imperilled New York-based Signature Bank in a bid to strengthen the banking system, treasury teams still had to deal with huge uncertainty and risks.
A bank failure can cause serious short-term liquidity issues that can affect vital expenditure such as payroll and supplier invoices, even if only for a few days. While in this instance bank deposits have been protected, this won’t always be the case and relying on one financial institution to deposit funds is becoming an increasingly risky strategy.
The positive news is that the industry is reacting. A Gartner survey in response to the closure of SVB found that one in four (28%) CFOs is now planning to diversify their deposits across more banks.
In my view, treasury teams and CFOs should look to diversify with a minimum of three banks. This means that should one bank get into difficulty, they have cash at hand to make vital payments, while not having to manage too many banking partners. But they need to carry out their due diligence to make sure that each of these banking partners have strong balance sheets and are also risk averse.
2. Question bank integrity
Treasury and risk teams should regularly question their banks, particularly regarding their investment policies. This was a critical error in SVB’s case. A bank that is serving startup tech firms shouldn’t be investing in longer-term US government bonds, which take a decade to yield results. If firms had investigated this more closely, they likely would have seen the risk and moved deposits elsewhere before the trouble started.
Treasurers should also question their banks when they offer above-the-market yields. SVB was reportedly offering positive yields on euro accounts when interest rates were negative. This should have raised suspicion because there is no such thing as a free lunch. When you are offered yield above risk-free assets then you are most likely taking on additional risk.
Banks should also know their customers and, in this case, the possibility of tech startups needing access to their cash quickly should have been anticipated by SVB, especially as investment has dried up over the past 12 months.
3. Check payment service provider and e-money institution policy
Treasurers should also take care when dealing with payment service providers and e-money institutions and ask for their safeguarding policy. Each bank must have one as directed by UK Payment Systems Regulator (PSR) and EU PSD2 rules. The most secure policies are those with no investment at all and which keep the funds as cash.
This means the cash is immediately available and stored with prime banks. This can provide treasury teams with the peace of mind that even if all clients withdraw funds, the providers and institutions can repay everyone.
4. Follow the markets
We are entering an even more uncertain economic period, with high-profile banks such as Credit Suisse being sold at a fire-sale price and others looking shaky. This should raise the alarm for treasurers.
It is vitally important treasurers continue to follow the markets. If a situation were to arise where a bank’s share price drops by 50% on a Wednesday, treasurers should act as if that bank would be closing on Saturday and withdraw their money.
There is a serious threat that more banks could go under and, to manage risk, it is important that treasury teams diversify their deposit funds and have a better understanding of their bank’s investment policies. Otherwise, they may not be so lucky next time.
For further insights on managing counterparty risk in the current environment, read TMI’s latest feature on the topic